Why Some Homeowner’s Premiums are Surprisingly High
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Here is a math problem that isn’t adding up for many of our clients: if their new house cost X, why is their homeowner’s policy premium based on a valuation that is significantly more than X? The answer is “replacement costs.” An answer, though, is not always the best explanation, so here, our team responds to some questions to help you better understand the concern.
1. What are replacement costs exactly, and why do they exceed market value?
Simply put, the price you pay to buy a home is different than the price you would pay to rebuild that home, for a variety of reasons. Foremost is the fact that insurance carriers focus on being able to cover the cost of rebuilding in worst-case scenarios. Often, that is a situation—a weather event, mostly—in which yours is not the only damage demanding attention. And when general contractors or materials are in short supply, costs skyrocket. (After Hurricane Sandy, for example, costs as much as doubled.) Further, high-end homeowners—and the best insurance carriers—want the job to be done right, so they are going to want to pay the most reliable contractors the price they ask.
Obviously, homes in areas that are more susceptible to catastrophic loss, such as those by the beach or in wildfire zones, will have higher replacement costs. But cost-increasing shortages occur for other reasons too. During the pandemic, the price of plywood quadrupled as factories slowed production. And, in general, it is just much more expensive to replace houses and interiors these days, because of updated building codes, increased labor costs and advanced technologies. In fact, Bloomberg News declared “Building a Home in the U.S. Has Never Been More Expensive.”
2. How does a carrier determine replacement costs?
This depends on the type of carrier. Mass-market carriers (such as Geico and State Farm) use an industry index that is based on square footage and geographic location. White-glove carriers, such as those we typically place clients with, send agents to inspect the home, and they take finishes and customizations into account as they make their estimate.
3. Do replacement costs cover like-for-like replacements?
If you are dealing with a mass-market insurance carrier, not necessarily. Aside from meeting updated building codes, there are no guarantees. In general, the definition of “replacing” is unspecified and thus left largely to interpretation. So even though you put in specially treated redwood floors, the insurer might only cover the price of pressure-treated pine. Or though you bought a frame home, your coverage might require it to be rebuilt with masonry.
However, with the policies we typically bind, the contracts obligate the insurer to make every effort to match the original materials. If you originally installed stained glass windows from a Venetian glass blower, we will find you a policy that potentially pays for their exact replacement, and if the particular craftsperson is no longer available, that insurance carrier will help you source an equivalent, or make up the difference. More to the point, if a rebuild exceeds the replacement cost, the carrier still covers it all, except in certain catastrophic-loss states like Florida and California.
It is just such protection, of course, that raises the cost of premiums, as fulfilling such promises necessitates carriers building an insurance pool sufficient to cover those costs. Because you don’t want to be surprised in the event of an emergency, it’s worth confirming your replacement costs coverage with your insurance professional.
4. How do replacement costs work in the case of condos and co-ops?
When you don’t live in a private home, the replacement costs in your homeowner’s policy cover all rebuilding from the walls in, while the building’s insurance carrier is responsible for what remains. In general, insurance carriers will not offer unlimited replacement costs for apartments. That makes it even more important to secure an initial inspection that results in an amount that adequately covers a proper rebuild.
5. What else do I need to know about replacement costs?
The time to contact your insurance professional is before you purchase a home, because understanding the replacement costs and associated premiums could affect your buying decisions. At the very least, you will know what you are signing up for.
Also, spend a moment to consider how much control you want to have over choosing the contractor or replacement materials or even how fast you want the job done. If you decide that you want your rebuild prioritized or replaced to your same standards, you need the type of coverage that guarantees such attention.
Lastly, it’s important to review your homeowner insurance coverage annually with your insurance advisor. That way, your policy covers inflation or any recent home upgrades, which will keep you more adequately covered should anything happen to your home.
Carving out time for such discussions is well worth the time and effort—as with any risk management program, an ounce of prevention goes a long way. Of course, should you need any assistance or need additional answers, we are available to consult.
